Understanding How Universal Default Clauses Work

A man confused by which bank to choose
Imagezoo / Getty Images

Universal default is a feeding frenzy that your lenders participate in. If you’ve got a universal default clause on one of your credit cards, you may have to pay the default rate even if you always pay on that card as agreed. Make sure you understand how universal default works so you’re not surprised during hard times.

How Universal Default Works

When you apply for a credit card, you probably skim through a lot of fine print.

The disclosures for APR, annual fee and promotional time period are pretty easy to see. You might miss the fact that the account you’re opening has universal default.

Universal default means that the lender can charge you a default rate if you default. That is, they can increase the interest rate they charge you if you do something "wrong." Makes sense so far, but the definition of default may surprise you. You don’t have to actually default on the loan in question to suffer from universal default. Instead, you might trigger the clause by the things you do with other accounts.

If you miss a payment on another account or if you accumulate too much debt, you might trigger a universal default clause. Think about what that means – if you make a late payment on your MasterCard, your Visa may go into “default”. Your Visa card could start charging you higher interest rates even though you never paid late on that account.

Consequences of Universal Default

It doesn’t take much imagination to see how things can get out of hand. If the interest rate skyrockets on your Visa card, your costs of borrowing will go up. Ultimately, your payments will increase. With more money due each month, you may find it difficult to make those payments.

Of course, this makes it more likely that you’ll pay late again and possibly even default on a loan.

It seems unfair that a creditor can change your rates based on your behavior with other lenders. Their argument is that you’ve become a greater risk, so they need to be compensated accordingly.

Lawmakers have taken a look at universal default clauses, but these clauses still exist in credit card agreements. However, credit cards can no longer jack up the rate on existing balances – they can only apply the default rate to purchases made after you default.

Universal Default Language

Here’s a fun exercise: Take a look at the agreements for all the credit cards you have. Skim through to see if you can find any universal default language. Here’s one below:

We may change the rates, fees, and terms of your account at any time for any reason. These reasons may be based on information in your credit report, such as your failure to make payments to another creditor when due, amounts owed, or the number of credit inquiries. . .

If you see this type of language, beware. If they raise the rate for any reason, borrowing money will look much different from what you originally expected. Of course, it's best to pay off credit cards completely each month, but if you happen to build up a balance you'll pay more after universal default.

Likewise, keep an eye on your credit. Too much debt, late payments and too many inquiries can trigger universal default. If you haven’t already, view your free credit reports available under the Fair Credit Reporting Act.